Intertemporal Competition for Institutional Capital in IPOs

Abstract

We propose a model of intertemporal competition for institutional capital in initial public offerings (IPOs) of equity. A firm issuing shares in period t courts institutional investors that also consider investing in a firm that will issue shares in the next period. We characterize stationary equilibria in two regimes: 1) when all issuers use bookbuilding, 2) when all issuers use fixed price offer.Issuers compete for institutional capital and in equilibrium pay rent to institutional investors: the shares are underpriced on average and institutional orders are treated favorably. Bookbuilding is more flexible than fixed price offer and permits the issuer to promise a higher return to institutional investors. When institutional resources are limited individually each issuer prefers bookbuilding. Yet, bookbuilding intensifies intertemporal competition for institutional capital among issuers. In this case the issuers would jointly benefit if bookbuilding would not be allowed. Our theory accords with many empirical findings about IPOs.